There are few more self-evident factors behind successful long-term, illiquid investing, such as corporate venturing and leveraged buyouts, than having correct timing on the macro-economy.
It is, therefore, significant that Olivier Garel, vice-president of mergers and acquisitions (M&A) has replaced Martin Grieve as head of fast-moving consumer goods (FMCG) company Unilever’s corporate venturing unit – this week’s Big Deal.
That the economy is just so important was again laid out by one of our subscribers, Jonathan Coslet, chief investment officer at private equity firm TPG, in a keynote speech at the Wharton University’s M&A West Leadership Summit this past week.
Coslet, who has effectively helped decide on all of TPG’s 300 investments in the past 21 years that have given the firm a 24% annual rate of return, said the macro was so important the firm had to assume it was constant in order to explore the importance of other factors behind its successes and failures.
The next most important issues were picking the right industry and finding management that could excel, with most of its best deals coming from replacing mediocre managers with top-performers.
But Coslet said the challenge of long-term investing was stopping buying before it was too late in the economic cycle, which in the last bubble was about 2006, two and a half years before investment bank Lehman Brothers failed. He said a lesson was to err on the side of being cautious.
He added: “The art of long-term investing was in finding the most important three factors out of the 20 possible pros and cons and making the right judgements on them.”
While venture investing can rely less on leverage than buyouts, although judging by some so-called venture capital firms putting in debt secured against tangible assets is more important than taking equity-type risk, the same challenge remains that it can be harder to grow in a shrinking economy than a rising one.
So, where are we currently? As this title has argued since its launch three years ago, this period and currently has been as perfect to be investing as gets.
Any firm that has been buying entrepreneurial assets since the initial fall-out of Lehman’s collapse passed has probably done more than just quite well. The next three years is likely to see increasingly good conditions for exits, while assets that can be turned with speed can also sell into the rising market before its next cyclical peak is reached anywhere between 2016 and 2020, if history over the past century is a guide.
As accountants Ernst & Young (E&Y) found in its latest survey of 1,600 executives in the first quarter, more than half thought the global economy was improving and their companies as a result were focusing on growth.
Pip McCrostie, global vice-chairman of E&Y’s transaction advisory services group that published the survey, said: “After years of conservative decision-making, executives are steadily trending toward an investing agenda….. However, our respondents are gravitating toward lower-risk value-creation and growth strategies, including organic growth, smaller bolt-on acquisitions, optimizing capital structure, strategic divestments and more rigourous cost control and operational efficiency.”
While the environment for M&A and IPOs is improving, bankers are arguing it could be better yet.
Last month, Gary Cohn, president of Goldman Sachs, in a presentation given at the Bernstein Strategic Decisions Conference, said global M&A volume in 2013 only made up about 4% of global stock market capitalisation, compared to a 20-year average of nearly 7%.
Flotations currently make up 0.2% of global market cap, which is half the 20-year average.
Cohn put the gap down to poor investor confidence due to macro-economic concerns, but this was changing as people became more optimistic.
Cohn said just closing half of the gap would mean around $700bn in additional M&A activity, with about $50bn in initial public offerings if the gap between current and historical averages was narrowed. Unspoken was whether the rapid rise in stock market valuations could be about to fall as the other way to take levels back towards their average.
What will be interesting in this current period is if these “lower-risk value-creation and growth strategies” will involve better coordination between the corporate venturing and M&A teams.
It is in this coordination that Garel’s background at Unilever could be important, given how few exits the FMCG company has had so far from its first two funds in the past decade.
When asked at the Wharton event whether its acquisitions from Cisco Systems’ corporate venturing portfolio performed better than the average of its 164 deals over 25 years, Philip Kirk, a director of corporate business development at the US-listed computer network equipment maker, said it had done relatively few and they had done well. He said its spin-in deals, such as Cisco’s $100m investment in Insieme, had been very successful.
Mike Foley, senior vice-president of corporate development at EA Sports, part of games developer Electronic Arts, which has no direct corporate venturing unit but has been affiliated with venture capital firm Vanedge Capital, added that it had found prices higher for venture-backed companies but they were cleaner to buy, although there was still risks in integrating any acquisition that dominated any such risk.
While it is unlikely there will be a surge of parent-to-portfolio company dealmaking in the near-term, it is an obvious area to look at especially if the latest wave of corporate venturing launches are becoming more strategic than financial in orientation.
Garel’s background could also help with M&A between its portfolio, which is something search engine provider Google’s corporate venturing unit has made a play on (see our previous Big Deal analysis).
But the bigger win for the company is if the corporate venturing unit’s insights into the wider entrepreneurial ecosystem and motivation of entrepreneurs helps the company buy better deals that can be more effectively integrated rather than the 50% to 85% of deals currently classed as failures.
Even a small improvement in success rates will be meaningful to shareholders and the smart corporate venturing units, such as media group Disney’s Steamboat Ventures (not coincidentally run by another former M&A professional), have long figured this out.
As TPG’s Coslet said in conversation after his Wharton presentation, he is looking for companies able to show a 50% improvement in enterprise value (EV) over its period of holding (of about three to eight years). This EV gain, which the debt and any multiple expansion magnifies, comes from revenue growth that can often be reasonably predictable or, the harder second derivative, better margins.
He said: “Change in margins is powerful but the hardest to figure out. Slack or tightness in labour is the biggest driver [as wages make up the bulk of costs in most industries]. We expect margin compression and use our growth team to identify disruption of portfolio companies or areas of supply compression to change margins [and targets to help the incumbents grow more quickly].”
By email afterwards he agreed that price to earnings multiples are increasing when analysts see or expect faster growth rather than just cost-cutting and so corporations that use a smart venturing strategy will gain an advantage and said it was “about using the collective and diverse knowledge that [exists] within the organisation to inform better judgments”.
The only remaining question is whether corporations will leave it to private equity firms to capitalise on such opportunities.